Mid-cap IT companies' June quarter performance all about niche play

While the Q1FY22 results of the top four IT players were about capturing growth being driven by cloud and digital transformation, the mid-cap IT firms' Q1 performance was all about their niche play and how they are growing faster than the larger players.

Take the case of Blackstone-backed Mphasis. The company’s US dollar revenue grew 6 per cent on sequential basis. It was able to ramp up its total contract value (TCV) to a record high of $505 million and also managed to meet Street expectations in margins.

“EBIT margins were largely in line with estimates. Sequentially, gross margins contracted 250 bps. This contraction was largely recovered at S&M and G&A levels. Notably, Mphasis was one of the few companies in the industry which was able to defend its EBIT margins despite elevated cost pressures. While most companies in the industry reported margin savings over previous several quarters on the back of Covid-19-led transient tailwinds, Mphasis continued with its investments. Accordingly, we see stronger ability to manage margins now as the Covid-19 tailwinds reverse,” said Sudheer Guntupalli and Hardik Sangani of ICICI Securities in their note post the results.

Mphasis' growth for the quarter was driven by its direct business, which grew 10 per cent on a constant currency basis. Again, Mphasis’ strength in banking and capital markets is making it ride the tech spend in this segment.

Unlike the top four or five IT players, when it comes to the mid-cap IT services players, every company has a different strategy and focus segments. For instance, Pune-based Persistent Systems has been a strong player in product and design-led services to BFSI, healthcare (32% yoy) and hi-tech verticals. In terms of growth, the company had a TCVof  $244.8 million of which annual contract value is $189 million.

While explaining the reasons behind the growth, Sandeep Kalra , CEO and executive director, Persistent Systems, said, “Companies look at us for product development across the segment, this makes us play in the agile and forward looking segment. We do not play much in the legacy architect systems. For instance, in the BFSI when a bank wants to move from a legacy system to a new age platform, we are brought on to the table. Similarly, in healthcare we have two offerings, we  do custom product platforms and the other is look at technology platforms and use it to provide services and build applications on that.”
 

“The management is confident of sustaining the revenue growth momentum in the coming quarters on the back of broad-based demand, robust deal intake, healthy deal pipeline and new logo additions. The company has moved to net revenue booking in IP reseller revenue from Q1FY22, which would lessen volatility in quarterly revenue performance. The action would hit revenue by 1.5-2% but would aid margins by 50-60bps in FY22,” said Dipesh Mehta and Monit Vyas of Emkay Research in their report.  

Same is the case with most of the mid-cap players. KPIT Technologies has been driving growth with its focus on the auto sector. Despite the fact that the automobile industry has been hit hard due to chip shortages, the company said that it has not seen any impact on its business. The reason being it partners with the world's top 25 auto manufacturers and is already working on future projects that would be launched in the 2024-25 timeline.

However, like in the case of the large players, the supply side pressure was evident on margins, with companies trying to retain talent by giving salary hikes and promotions. With attrition picking up, almost every company has hit the campus to hire in large numbers. For instance, L&T Infotech plans to hire 4,500 freshers in FY22 (1.5x of FY21 fresher hiring)

In case of Mindtree, the attrition was  13.7 per cent, up 160 bps Q-o-Q. The company added its highest ever employee addition in Q1 at 3,442. The management said that it will be hiring more freshers.

Analysts expect that going ahead too, salary hikes, travel cost will impact margins of mid-cap IT services. What needs to be seen is how much of it gets balanced with revenue growth.